Financial Accounting and Financial Accounting and its Economic Contextits Economic Context

Presentations for Chapter 1 by Glenn Owen

Key PointsKey Points The economic role of financial accounting statements The standard audit report, management letter, and

footnotes to the financial statements. The four financial statements and the kind of financial

information each provides. The two forms of investment, debt and equity, and

how the information of the financial statements relates to them.

Why ethics is important in the accounting process. The Securities Exchange Commission, the Financial

Accounting Standards Board, and the development of generally accepted accounting principles.

The current status of international accounting practices and standards.

The Financial The Financial Accounting ProcessAccounting Process

Managers prepare Users assess

Investment andcredit decisions are made

Decisions have an effect

Basic Relationships in the Basic Relationships in the Financial Reporting ProcessFinancial Reporting Process

Financial Information

and Fees

Capital Capital ProvidersProviders

Companies Companies (Managers)(Managers)

AuditorAuditor

Legal Liability

Interest, Principle, & Dividends

Debt and Equity Investments

Audited Financial Information

Professional Reputation and Ethics

Board of DirectorsSets company policyDeclares dividendsSets management compensationHires/fires managementAppoints audit committee

Board of DirectorsSets company policyDeclares dividendsSets management compensationHires/fires managementAppoints audit committee

StockholdersElect board of directors

StockholdersElect board of directors

ManagementManages company

ManagementManages company Audit fee AuditorAuditor

The Role of the Board of The Role of the Board of Directors and Audit CommitteeDirectors and Audit Committee

Audit CommitteeHelps to choose auditor and monitors management and auditor

Audit CommitteeHelps to choose auditor and monitors management and auditor

Communicating with UsersCommunicating with Users

Standard Audit Report Management Letter Financial Statements Footnotes

Standard Audit ReportStandard Audit Report

Identifies management’s responsibility for financial statements, that the auditors performed an audit, and they are responsible for the audit opinion

Indicates that the auditor applied generally accepted auditing standards

States that financial information is fairly presented in accordance with generally accepted accounting principles

Management LetterManagement Letter

Indicates that management – Is responsible for preparation and integrity of

statements– Has prepared statements in accordance with

GAAP– Has used their best estimates and judgment

States that the company maintains a system of internal controls

Financial StatementsFinancial Statements

Balance Sheet– Lists assets, liabilities, and equity at a given point in

time Income Statement

– Contains revenues earned and expenses incurred over a period of time

Statement of Retained Earnings– Reconciles retained earnings amounts from one period

to the next Statement of Cash Flow

– Reconciles cash amounts from one period to the next

FootnotesFootnotes

Provide additional information about the dollar amounts

Indicate accounting methods usedIdentify assumptions and estimates made by

management

The Accounting The Accounting Policymaking ProcessPolicymaking Process

Generally Accepted Accounting Principles

Actual Accounting Practices

Economic Consequences

Perceived economic

consequences

Policymakers

SEC

FASB

Policymakers

SEC

FASB

Congress, White House, government agencies Public hearings, letters

Public Input

Public Input

The Four Kinds of AccountingThe Four Kinds of Accounting

Economic Entity

Managers SystemFinancial

InformationRecipients Decisions

Financial Accounting

Not-For-Profit Accounting

Managerial Accounting

Tax Accounting

The Four Kinds of AccountingThe Four Kinds of Accounting

Economic Entity

Managers SystemFinancial

InformationRecipients Decisions

Financial Accounting

Profit-making companies

Finance or accounting department

GAAP •Income statement •Balance sheet•Statement of retained earnings•Statement of cash flows•Other disclosures•Auditor report

External•Investors•Creditors•Suppliers•Employees•Managers•Government•General public

•Equity and debt investments•Contract negotiations•Regulation•Dividend payments

The Four Kinds of AccountingThe Four Kinds of Accounting

Economic Entity

Managers SystemFinancial

InformationRecipients Decisions

Not-For-Profit Accounting

Nonprofit entities

Finance or accounting department

Fund accounting principles

•Balance sheet•Funds flow statements

External•Creditors•Government•General public

•Debt investments•Budget allocations

The Four Kinds of AccountingThe Four Kinds of Accounting

Economic Entity

Managers SystemFinancial

InformationRecipients Decisions

Managerial Accounting

All entities Internal accounting department

Company information system

•Management reports•Production costs•Performance, evaluation, etc.

Internal Managers

Operating decisions

The Four Kinds of AccountingThe Four Kinds of Accounting

Economic Entity

Managers SystemFinancial

InformationRecipients Decisions

Tax Accounting

All entities Finance or accounting department

Internal Revenue Code

Official tax forms:•1040 for individuals•1120 for corporations

External Internal Revenue Service

Collection of government revenues

C O P Y R I G H T

C o p y r i g h t © 2 0 0 3 , J o h n W i l e y & S o n s , I n c . A l l r i g h t s r e s e r v e d .R e p r o d u c t i o n o r t r a n s l a t i o n o f t h i s w o r k b e y o n d t h a t p e r m i t t e d i n S e c t i o n 1 1 7 o f t h e 1 9 7 6 U n i t e d S t a t e s C o p y r i g h t A c t w i t h o u t t h ee x p r e s s w r i t t e n p e r m i s s i o n o f t h e c o p y r i g h t o w n e r i s u n l a w f u l . R e q u e s t f o r f u r t h e r i n f o r m a t i o n s h o u l d b e a d d r e s s e d t o t h e P e r m i s s i o n s D e p a r t m e n t , J o h n W i l e y & S o n s , I n c . T h e p u r c h a s e r m a y m a k e b a c k - u p c o p i e s f o r h i s / h e r o w n u s e o n l y a n d n o t f o r d i s t r i b u t i o n o r r e s a l e . T h e P u b l i s h e r a s s u m e s n o r e s p o n s i b i l i t yf o r e r r o r s , o m i s s i o n s , o r d a m a g e s , c a u s e d b y t h e u s e o f t h e s e p r o g r a m s o r f r o m t h e u s e o f t h e i n f o r m a t i o n c o n t a i n e d h e r e i n .